There are serious concerns that the US economy is grinding to a halt and may slip into another recession. Growth in quarterly Gross Domestic Product in the United States has averaged 3.28% between 1947 and 2010. By comparison, growth was 1% in the second quarter of 2011 over the previous quarter, up only slightly from 0.4% growth in the first quarter.
As pointed out by Ruchir Sharma, the Head of Emerging Markets, Morgan Stanley Investment Management: "When US economic growth has fallen below 2% on a year-on-year basis in a quarter, the economy has entered a recession in seven out of the previous 10 instances. The economy grew below that threshold level in the second quarter of this year."[i]
However, the financial markets are not yet sending out any warning signs. The yield curve (the spread between 10 year and 3 month government bonds) continues to be steep. Most recessions in the past have been preceded by an inverted yield curve, i.e., 10 year interest rates falling below the 3 month interest rate. Based on the yield curve, the New York Fed predicts that the probability of a recession before July 2012 is less than one percent (0.8%).
Corporate profitability is also sending out positive signals. Usually, profits dip before a recession but they grew 3% in the second quarter, up from 1% rise in the first quarter.
While most of the reliable indicators are not suggesting a double dip scenario, economists are still not discounting the possibility of a recession. In fact, various informal polls, such as by Wall Street Journal and USA Today, suggest that the likelihood of recession has doubled over the past couple of months.
The cause for concern is that consumers and businesses are still apprehensive. Increase in consumer spending decelerated to 0.4% in the second quarter, compared with an increase of 2.1% in the first quarter. The Thomson Reuters/University of Michigan Consumer Sentiment Index has been indicating stagnation. The ISM Manufacturing PMI was at 50.6 in August, barely managing to remain in the expansion territory.
There are four primary factors that account for the current passive response from the private sector to the recovery process:
· No jobs or low wages: The job market remains glum, especially for those who are unemployed. In fact, employment in sectors like construction, information, and government continues to fall. The unemployment rate in July was recorded at 9.1%, a slight dip from 9.2% in June, which was more a result of people dropping out of the job market rather than a net addition to the share of workers with jobs.
· Beleaguered public finances: The government's ability to boost the economy and employment has been severely curtailed. Each level of government is under financial stress in the US. Adding to the uncertainty in the medium and long term (beyond 2012) is the impact of cuts in government expenditure in the aftermath of the recent deal in the Congress to restructure public debt. The deal envisages cuts worth $2.5 trillion—nearly $1 trillion in discretionary spending and an additional $1.5 trillion through a bipartisan committee process, which would also consider entitlement and tax reform (or cuts in mandatory spending). The most recent estimates from CBO (which include the impact of the $1 trillion cuts in discretionary spending) suggest that discretionary spending will barely increase from $1250 billion to $1301 billion between 2012 and 2021. This means that assuming a 2% rate of inflation over this period, discretionary spending will shrink by nearly 13% in real terms over the next decade. Compare this with an increase of 6.2% per year in real terms between 2000 and 2010. The cuts envisaged by the Congress will mean that government spending will no longer make a positive contribution to GDP growth in the medium and long term.
· Housing market still in slump: Suppressed housing prices have a negative bearing on consumer confidence and spending, creating a vicious cycle as it reduces the chances of a strong recovery in the housing market further. Barring minor upticks here and there, the broader story remains that of continued housing market slump.
· The never ending EU crisis: The situation in the EU has only worsened over time. Greece, Portugal, and Ireland have been given junk ratings and Italy seems to have caught the contagion. With political difficulties within each nation and the economic union, a clear solution to the crisis is still not apparent. The Economist has compared the current scenario in the US and Europe to the case of Japan, which experienced the "lost decade" because the policy makers couldn't agree on a course of action in time. The risk is that the EU may be headed towards a financial crisis, which would impact the US and global market negatively.
The entire developed world appears to be pinning all their hopes on the 'emerging economies' to pull them out of the current morass. Evidence, however, suggests that the emerging economies have not really 'decoupled' from the developed world. Signs of weakness in the developed economies will likely result in weaker growth in emerging economies.
The Federal Reserve's announcement to keep the Federal funds rate—the overnight lending rate between banks—"extremely low" until at least mid-2013 (suggesting that the funds rate will likely remain between 0% and 0.25% through 2012, and most likely, until mid-2013) may only have added to the uncertainty and lack of confidence. Given that the economy appears to be in a liquidity trap, it is unlikely to boost the recovery process.
Given the present state of affairs, the US economy is likely to underperform this year and will likely grow only moderately in the medium term. As the Conference Board, the not-for-profit research association based in the US, put it: "Episodes of slower growth, alternating with only moderately firmer growth is the current reality in this post-crisis expansion." [ii]
The possibility of a recession in the US in 2012 appear very real, especially if the high-unemployment-low-wage scenario coupled with the slump in the housing market results in weak or negative growth in consumer spending and private investment gets strangled due to political and economic uncertainties across the globe.
[i] http://economictimes.indiatimes.com/view-point/another-us-recession-would-be-consistent-with-its-financial-history-ruchir-sharma-head-of-emerging-markets-morgan-stanley-investment-management/articleshow/9950225.cms
[ii] "Economic forecast for the US economy," The Conference Board, July 13, 2011, <http://www.conference-board.org/pdf_free/economics/2011_07_1311.pdf
